Conclusion: Despite sovereign debt concerns out of Europe getting most of the attention, China still leads the way when it comes to the forward outlook for global growth. With that said, continued slowing in China will not bode well for U.S. Equities – despite a hopeful 2H10 domestic earnings growth story.
We’re setting up to subtract one more point from the bullish case for U.S. equities – earnings. Perma-bulls have been touting the 2H10 EPS growth story as the lone savior for U.S. equities and it looks like that could roll over if China continues to slow.
Our proprietary Hedgeye China Index combines the Shanghai Composite, Hang Seng, and Copper – all of which are leading indicators for global growth – and is one important analytical tool we use to get a read-through on the forward global growth outlook. You’ll note that our index peaked on April 14th – nine days prior to the 4/23 cyclical peak of the S&P 500.
Since then, we’ve seen lower-lows in the Hedgeye China Index – which, much to the dismay of U.S. equity perma-bulls, happens to coincide quite nicely with 2010’s unreported S&P 500 EPS estimates. In fact, the trailing three month positive correlation between the two series is 0.95. That’s an r-squared of 0.91, which, by all statistical measures, is very significant.
Over the last three months, the unfolding of the European sovereign debt crisis has dragged down many global equity markets and the remaining bulls out there are failing to realize is that that issue is not going away any time soon. In fact, we expect a European-style sovereign debt crisis to manifest itself in the U.S. over the next 3-6 months. Combine that with our bearish outlook on U.S. housing prices and the U.S. consumer, and it’s easy to see why the 2H10 U.S. earnings growth story won’t be enough to hold firm the fading bid for U.S. equities.
Yesterday, I said that if the US stock market were to break down to lower-lows that sentiment would begin to get Bearish Enough. Yesterday’s close of 1050 was a fresh YTD low for 2010, so we’re finally in motion here. But remember that intermediate term bottoms are processes, not points…
The SP500 is in what Hedgeye calls a Bearish Formation (bearish across all 3 investment durations: TRADE, TREND, and TAIL). In the chart below, Darius Dale and I have outlined the both the TREND (intermediate term) and TAIL (long term) lines of resistance at 1078 and 1144, respectively.
Friday’s breakdown through the long term TAIL line of support (1078) came on accelerating volume, spiking volatility (+20.4% day in the VIX), and a critically negative fundamental (the SPX correlation to private payrolls is 0.72, so the 1st meaningful sequential deceleration in private hiring since December obviously caught Mr. Macro Market’s attention).
Now that anyone with a calculator can look back on April 23rd for what it was (the peak for this stage of the market cycle), our risk management task is to simply find a zone where we can COVER/BUY with a margin of safety that’s tolerable. Given that the Hedgeye Asset Allocation Model currently has a zero percent allocation to US Equities, we can afford to be patient and picky here.
As of 2PM EST, my refreshed immediate term downside target for the SP500 is warning for another lower-low in the 1036-1038 zone. There are still plenty of people who think 1040 is legitimate support (an intraday low in 2010 that didn’t confirm on a closing basis), so look at that for what it is – consensus – because the gravitational suck of the math in my model tends to pull prices to the most excruciating point of the Pain Trade.
In terms of catalysts, most of the “fundamental” ones are going to be negative. In terms of a sentiment catalyst, what we need here is a major US stock market Bull to come out and capitulate (Thomas Lee (JPM), Byron Wien (Blackstone), or Barton Biggs). Then we can pick up the pieces and attempt to build a credible base to bounce back up to test 1078 from again. The lower we go, the more attractive the prospective return on that bounce becomes…
Keith R. McCullough
Chief Executive Officer
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Economy Grew 9% in First Quarter
Brazil’s official statistical agency, IBGE, reports today that Brazil’s economy grew 9% in the first quarter over the year-ago period, and that GDP was up 2.7% over the last quarter of 2009. They say this puts Brazil’s economy in a similar position to the other “BRIC” economies. Already reporting for this year were China – with an 11.9% annualized growth rate – and India, at 8.6%.
Brazil’s central bank said the number was in line with their growth estimates. We have not reviewed Brazil’s central bank previous estimates, but the projected range for this quarter was between 7.5%-10%. This looks like a gimme, and we wonder why a central bank would give such generous leeway, unless it was trying to make sure the government couldn’t possibly disappoint.
Press commentary says Brazil is running counter to the economic trends in Europe, observing that Britain’s new government is talking austerity measures, and Germany just announced significant the layoffs of public service employees and personnel cuts in the armed services. Brazilian government spending, meanwhile, continues to grow, raising fears of inflation. The strong growth number just reported for the first quarter was strong, but growth is noticeably slower in the current quarter.
Brazil’s election authorities fined President Lula – for the fifth time – for campaign violations. A sitting president is not allowed to campaign during the preliminary stages of an election, only once the official campaign season has started and the official candidates have been named. Lula appeared before a federation of labor unions in a May Day celebration and said the country “needs continuity” – a clear reference to his hand-picked successor, Dilma Rousseff. The mistake will cost him about US$4,500.
Polling shows recent gains in Rousseff'’s popularity, despite the scandal that surfaced in the past week, where it was revealed that a journalist, together with a former senior police official and a former military intelligence officer were planning an espionage campaign aimed at presumptive opposition candidate Jose Serra.
Under Brazil’s constitution, Lula, who has held the presidency for two terms, cannot run for a third consecutive term. In a newspaper interview this week, Lula said he would not rule out the possibility of his returning to run for president in 2014. He emphasized, however, that he is looking forward to attending the World Cup games that year – when Brazil will be the host – as a private citizen.
Brazilians will vote for a new president on 3 October.
Chief Compliance Officer & Managing Director
MCD reported May sales today and as I stated yesterday although trends remain positive on an absolute basis, expectations, particularly in the U.S., are ahead of current trends. U.S. same-store sales came in +3.4%, below the street’s +4.3% estimate. Relative to the ranges I outlined in my sales preview note, which look at reported trends versus recent two-year trends, the U.S. segment posted a BAD result and both Europe and APMEA came in NEUTRAL.
Adjusting for calendar shifts, two-year average trends in the U.S. slowed again in May to February levels of below 4% after accelerating in the prior two months to closer to +5% while Europe and APMEA were in line to slightly better. For reference, MCD lapped the initial national launch of its McCafe advertising campaign in mid-May so it will be important to watch how McCafe fares in its second year. MCD reported that the recent addition of Frappes to the McCafe line-up helped drive same-store sales growth in May, but I continue to believe that the beverage initiative will complicate operations longer-term.
FX Headwind…MCD also reported today that for the full year foreign currency translation is expected to have a negative impact on EPS, which reflects a change from the company’s prior expectation of a slight benefit.
R3: REQUIRED RETAIL READING
June 8, 2010
Under the hood of DG’s strong Q2 results are several notable highlights including the willingness of the lower-end consumer to purchase incremental non-consumables.
DG reported another strong quarter, with earnings of $0.42 vs. the Street at $0.34. Recall that the company was on the road for a secondary in the early part of the quarter, which in some way was probably a big vote of confidence in favor of the company’s underlying trends. Timing aside, there’s no denying that this was another solid quarter, on top of difficult comparisons with the prior year. Yes, same store sales were better than forecast (up 6.7% vs. a 4.1% expectation) but gross margins and leverage on SG&A were better too. In looking below the surface there were a couple of notable changes that stand out:
- DG’s merchandise mix showed one of the more dramatic sequential changes we’ve seen in several quarters, with consumables growth slowing and seasonal and apparel categories picking up. Notably, apparel posted a 6.7% increase on top a 7.6% increase LY. This is clearly a win for gross margins over time, if sustainable. Either way, the conference call will be telling as we wait to see if management takes credit for the changes in mix or if this is simply a byproduct of comparisons with last year.
- Dovetailing on the mix comment, was a very strong performance from the company’s seasonal category. For the quarter, seasonal increased by 20.6%. Favorable weather was likely a key contributor, as we have seen across the entire retail space in early Spring. Nonetheless, the willingness of the lower-end consumer to purchase incremental non-consumables is noteworthy.
- Inventory remains well controlled, but not as stellar in quarters past. On an 11.9% increase in sales, DG’s inventories increased by 10%. While this is still a favorable spread, see the SIGMA chart below to see the progression over the past few quarters in the company’s inventory management.
LEVINE’S LOW DOWN
- GIII’s push to transform outerwear specialist Andrew Marc into a lifestyle brand continues. Management believes category extensions for the brand are “endless”. As such, the company recently announced the license of the brand for Men’s denim and sportswear with Jones New York. The men’s business will be built under three sub-brands, which are expected to be sold through specialty and department store channels. Other recent licenses include men’s small leather goods, luggage, footwear, and women’s accessories.
- Keep an eye on the Boomerangers. Who are these people? Defined as young adults who have moved home with their parents after living away and being independent, this newly defined demographic is growing. Approximately 13% of parents report Boomerang children according to a Luminosity poll. Marketers are becoming more excited about this niche category of consumers due to their ability to influence self-purchases as well as those made by their families living under the same roof.
- Add Crocs to the list of footwear companies looking to capitalize on “barefoot” technology. While toning has certainly received a disproportionate share of attention, let’s not forget the growing belief that we’re all better off walking around barefoot (for health and anatomical reasons). Building on this concept is Crocs ABF, short for “as close to barefoot as it gets”. The new sandals come in a variety of colors and designs, priced from $19.99 to $29.99.
Puma to Consider More Acquisitions - Puma will consider further acquisitions if any potential target complements its offerings. CEO Jochen Zeitz said: "I can well imagine making acquisitions so long as these are complementary to Puma and move it forward." Puma acquired the golf equipment brand Cobra, which it bought in March from US diversified consumer products company Fortune Brands Inc. In terms of Puma's prospective growth, Zeitz said the company still believed it had the long-term potential of generating sales of more than 4 bn euros ($4.88 billion) despite the recession. <fashionnetasia.com>
Hedgeye Retail’s Take: With sales stalled at ~€2.5Bn over each of the last 3-years, acquisitions are critical to Puma’s goal of achieving of €4Bn in sales. The company can also be very liberal with its definition of “complementary” acquisitions given its brand exposure in running, football, baseball, cricket, and motorsports in addition to soccer.
Indian Garment Exports Down 2.64% in '09 to '10 - After new data showed the value of the country's garment exports fell by 2.6% in the year to March, Indian apparel exporters are calling for a tax on cotton yarn exports again. <fashionnetasia.com>
Hedgeye Retail’s Take: Either way you slice it this is yet another contributing factor to rising costs.
Vietnam Leather Export Target May be Unattainable - Vietnamese leather and footwear industry is concerned that the sector might not be able to reach the 2010 export target of US$5.3 billion. <fashionnetasia.com>
Hedgeye Retail’s Take: With more and more chatter that China costs are on the rise (driven by wage increases, labor shortages, and raw materials) is now the time for Vietnam to cut price and take back share?
Nike Introduces a Heart Rate Monitor Training Device - Nike, Inc and Polar have introduced the Polar WearLink+ that works with Nike+, enabling users to run and train with heart rate monitoring. This new product works with the Nike+ SportBand and the Nike+ iPod Sport Kit, enabling users to run and train with heart rate monitoring for the first time. It is worn comfortably around the chest and transmits the user's heart rate wirelessly to their Nike+ iPod Sport Kit or SportBand. It will improve the training experience of Nike+ users helping them to understand how hard they are working in any given run. <sportsonesource.com>
Hedgeye Retail’s Take: The latest innovation in self-monitoring workout accessories for Nike athletes serves as a reminder that many stay fit the old-fashioned way – they earn it.
BEBE and 90210 Partner for Contemporary Line - Bebe Stores Inc. and CBS Consumer Products are partnering on a Bebe for 90210 contemporary clothing collection based on CBS Television Studios’ “90210” series for The CW. It’s a collaboration between producers and wardrobe stylists from the show and Bebe’s creative design team. The line will be introduced simultaneously on-air and in stores. The label will launch in conjunction with new episodes of the series’ third season this fall and include styles worn by characters in the show along with products inspired by the series. <wwd.com/retail-news>
Hedgeye Retail’s Take: Capitalizing on its Californian heritage, you have to tip your hat to Bebe and its recent moves partnering recently with the Kardashians and now 90210 in an effort to stay relevant.
Hermès International Cautions Growth to Slow in Back Half - Sales at Hermès International rose even faster in April and May than the 18.5% increase registered in the first quarter, but these growth levels should drop off in the second half, CEO Patrick Thomas said Monday. Sales continue to progress at an extremely good rate for the time being, in fact at a rhythm superior even to the first quarter, especially in watches. The CEO added, “This very strong growth in the first half of the year must not prompt us to overestimate our forecasts for the end of the year.” <wwd.com/business-news>
Hedgeye Retail’s Take: Not exactly a surprise here as comps get increasingly less favorable and pent up demand wanes over the balance of the year.
Paris Stores Denied Bid for Sunday Trading - City Hall rejected some Paris department stores that bid to lift a ban on Sunday trading. In a joint statement Monday, the retailers said Mayor Bertrand Delanoë had turned down an application to classify the shopping district around Boulevard Haussmann as a tourist zone, which would have given them the green light to open every Sunday like stores on the Champs-Elysées. Such a move would have boosted tourism and the local economy by generating additional revenue and creating at least 600 jobs, they argued. <wwd.com/retail-news>
Hedgeye Retail’s Take: Gotta love the archaic old-school laws. Anyone try to shop in Bergen County, NJ on a Sunday?
Li&Fung To Produce More for TapouT - TapouT, a mixed martial arts apparel and gear brand, has extended its licensing deal with LF USA, a subsidiary of Li & Fung Limited, to include men's and juniors' sportswear. LF USA's Wear Me Apparel division will produce and distribute the sportswear under the TapouT and MPS brands. The division has produced product for TapouT since 2008. The new TapouT sportswear will hit retailers next month. <licensemag.com>
Hedgeye Retail’s Take: Keep an eye on this growing apparel and footwear category, which appears to be gaining momentum. While MMA has been around for a while, we’re just beginning to see sizable company’s taking advantage of the growing market. Just last week, Payless CEO Matt Rubell highlighted a similar opportunity with its MMA brand, Strikeforce.
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